Carney’s Options for Cooling Housing

The Bank of England has kicked off measures to cool the market, but it can go further.

Bloomberg News

Bank of England officials meet Tuesday to discuss potential risks to the stability of the U.K.’s financial system. Top of their list: the U.K. housing market.

Rapidly-rising real-estate prices have sparked fears that would-be buyers will take out loans they may struggle to repay, particularly when interest rates rise. That could put a brake on spending and slow the recovery. Outright defaults could hurt Britain’s banks and arrest the flow of credit to other parts of the economy.

The U.K. hasn’t reached such a crisis-point yet. Mortgage lending, net of repayments, is subdued overall relative to past norms and only in London and England’s wealthy southeast do buyers appear to be in real danger of over stretching themselves.

Officials are nonetheless worried. BOE Gov. Mark Carney and others have said an overheating housing market poses a risk to the recovery. The central bank has already taken small steps to cool it down.

Funding for home loans through a program designed to boost lending to households and businesses has been cut off. New rules mean borrowers have to prove they can weather a rise in rates, which could start creeping up before the end of the year. And banks have been warned not to let underwriting standards slip.

Some lenders, including Lloyds Banking Group PLC and Royal Bank of Scotland Group PLC, have already said they won’t let buyers of expensive homes in London borrow more than four times their income. Banks also face stress tests this year to ensure they can withstand a fall in house prices.

Many observers expect the BOE to keep up the pressure. The central bank’s Financial Policy Committee, a panel of central bank officials and outside experts who monitor the stability of the financial system, has an array of so-called “macroprudential” tools at its disposal to nip risks in the bud. The committee meets Tuesday and its recommendations will be published June 26.

One thing to remember is the FPC doesn’t set interest rates–that’s the job of the BOE’s Monetary Policy Committee. Mr. Carney has said higher rates will be the last line of defense against financial-stability risks given the economy is still recovering.

Here’s a rundown of some of the options the central bank has.

- Tighten lending standards. The FPC can request banks impose even stricter tests on whether new borrowers can repay their mortgages, particularly if interest rates rise. This seems a likely first step to clamp down on the riskiest lending without penalizing creditworthy borrowers, analysts say. Officials may consider recommending a cap on how much buyers can borrow relative to their income, or relative to the value of the property they wish to buy.

- End Help-to-Buy. A government-run program to help first-time buyers get a foot on the housing ladder is unpopular with economists, who worry it is fueling expectations that house prices will continue to rise. A request to the government this month to change its terms or close it down seems unlikely, however, since a formal review is scheduled for September and only a small number of buyers are actually using it.

-Raise bank capital requirements. The FPC can order banks to finance their mortgage books with more equity to protect against losses, or it can raise capital requirements more broadly. Neither of these options seem likely at this stage. Banks have added some £150 billion ($253.5 billion) in capital in the last couple of years and officials will want to see how lenders perform in November’s stress test.

-Do nothing. Officials may choose to keep up the “we’re vigilant” rhetoric while waiting to see if the market cools by itself. Indeed, U.K. house price inflation eased in June as an increase in the supply of property for sale alleviated some upward pressure on values, according to a survey by online estate agent Rightmove PLC Monday.

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